2.2.1 Forms of variable consideration

Paragraph 51 of IFRS 15 describes ‘variable consideration’ broadly to include discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses (e.g. meeting specified performance conditions where there is uncertainty about the outcome) and penalties. [IFRS 15.51]. Variable consideration can result from explicit terms in a contract to which the parties to the contract agreed or can be implied by an entity’s past business practices or intentions under the contract. It is important for entities to appropriately identify the different instances of variable consideration included in a contract because the second step of estimating variable consideration requires entities to apply a constraint (as discussed further at 2.2.3 below) to all variable consideration.

The Board noted in the Basis for Conclusions that consideration can be variable even when the stated price in the contract is fixed. This is because the entity may be entitled to consideration only upon the occurrence or non-occurrence of a future event. [IFRS 15.BC191]. For example, IFRS 15’s description of variable consideration includes amounts resulting from variability due to customer refunds or returns. As a result, a contract to provide a customer with 100 widgets at a fixed price per widget would be considered to include a variable component if the customer has the right to return the widgets (see 2.4 below).

In many transactions, entities have variable consideration as a result of rebates and/or discounts on the price of products or services they provide to customers once the customers meet specific volume thresholds. The standard contains the following example relating to volume discounts. [IFRS 15.IE124-IE128].

IFRS 15 requires entities to disclose how they estimate variable consideration when determining the transaction price in contracts with customers, including the following:

• significant payment terms (including whether the consideration is variable and whether the estimate is typically constrained, rights of return, etc.); and
• significant judgements used in determining the transaction price, including information about methods, inputs and assumptions used to estimate variable consideration and assess whether the estimate is constrained.

As a result, entities may need to explain the different forms of variable consideration included in their contracts with customers. Entities, therefore, need to carefully consider and identify all forms of variable consideration when they determine the transaction price for their customer contracts and review their disclosures to verify that they meet the disclosure requirements in paragraphs 119, 123 and 126 of IFRS 15 (see Chapter 32 for further discussion of disclosure requirements). [IFRS 15.119, 123, 126].

See Chapter 28 at 3.6.1.E for discussion on whether volume rebates and/or discounts on goods or services should be accounted for as variable consideration or as customer options to acquire additional goods or services at a discount. See Chapter 28 at 3.6.1.C for a discussion on distinguishing between a contract that contains an option to purchase additional goods or services and a contract that includes variable consideration based on a variable quantity (e.g. a usage-based fee).

2.2.2 Estimating variable consideration

If a contract with a customer includes variable consideration, paragraph 50 of IFRS 15 (see 2.2 above) states that ‘an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer’. [IFRS 15.50]. Entities are generally required to estimate variable consideration at contract inception and at the end of each reporting period (see 2.2.4 below for reassessment requirements). at 2.2.2.A below, we discuss limited situations in which the estimation of variable consideration may not be required.

Variable consideration generally needs to be estimated, instead of waiting for the variable consideration to be received or known with a high degree of certainty (e.g. upon receipt of a report from a customer detailing the amount of revenue due to the entity). For example, it would not be acceptable for entities that sell their products through distributors or resellers to wait until the end-sale has occurred if the only uncertainty is the variability in the pricing. This is because IFRS 15 requires an entity to estimate the variable consideration (the end-sales price in our example) based on the information available, taking into consideration the effect of the constraint on variable consideration (see at 2.2.3 below), unless one of the limited situations discussed at 2.2.2.A below occurs.

An entity is required to estimate an amount of variable consideration by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled:

• The expected value – ‘the expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics.’
• The most likely amount – ‘the most likely amount is the single most likely amount in a range of possible consideration amounts (i.e. the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes’ (e.g. an entity either achieves a performance bonus or does not). [IFRS 15.53].

An entity applies one method consistently throughout the contract when estimating the effect of an uncertainty on an amount of variable consideration to which the entity will be entitled. In addition, an entity is required to consider all the information (historical, current and forecast) that is reasonably available to the entity and identify a reasonable number of possible consideration amounts. The standard states that the information an entity uses to estimate the amount of variable consideration would typically be similar to the information that the entity’s management uses during the bid-and-proposal process and in establishing prices for promised goods or services. [IFRS 15.54].

An entity is required to choose between the expected value method and the most likely amount method based on which method better predicts the amount of consideration to which it will be entitled. That is, the method selected is not meant to be a ‘free choice’. Rather, an entity must select the method that is best suited, based on the specific facts and circumstances of the contract. [IFRS 15.53].

An entity applies the selected method consistently to each type of variable consideration throughout the contract term and updates the estimated variable consideration at the end of each reporting period. Once it selects a method, an entity is required to apply that method consistently for similar types of variable consideration in similar types of contracts. In the Basis for Conclusions, the Board noted that a contract may contain different types of variable consideration. [IFRS 15.BC202]. As such, it may be appropriate for an entity to use different methods (i.e. expected value or most likely amount) for estimating different types of variable consideration within a single contract.

Entities determine the expected value of variable consideration using the sum of probability-weighted amounts in a range of possible amounts under the contract. To do this, an entity identifies the possible outcomes of a contract and the probabilities of those outcomes. The Board indicated in the Basis for Conclusions that the expected value method may better predict expected consideration when an entity has a large number of contracts with similar characteristics. [IFRS 15.BC200]. This method may also better predict consideration when an entity has a single contract with a large number of possible outcomes. The IASB clarified that an entity preparing an expected value calculation is not required to consider all possible outcomes, even if the entity has extensive data and can identify many possible outcomes. Instead, the IASB noted in the Basis for Conclusions that, in many cases, a limited number of discrete outcomes and probabilities can provide a reasonable estimate of the expected value. [IFRS 15.BC201].

Entities determine the most likely amount of variable consideration using the single most likely amount in a range of possible consideration amounts. The Board indicated in the Basis for Conclusions that the most likely amount method may be the better predictor when the entity expects to be entitled to one of two possible amounts. [IFRS 15.BC200]. For example, a contract in which an entity is entitled to receive all or none of a specified performance bonus, but not a portion of that bonus.

The standard requires that when applying either of these methods, an entity considers all information (historical, current and forecast) that is reasonably available to the entity. Some stakeholders questioned whether an entity would be applying the portfolio approach practical expedient in paragraph 4 of IFRS 15 (see Chapter 28 at 2.3.1) when considering evidence from other, similar contracts to develop an estimate of variable consideration using an expected value method. The TRG members discussed this question and generally agreed that an entity would not be applying the portfolio approach practical expedient if it used a portfolio of data from its historical experience with similar customers and/or contracts. The TRG members noted that an entity could choose to apply the portfolio approach practical expedient, but would not be required to do so.5 Use of this practical expedient requires an entity to assert that it does not expect the use of the expedient to differ materially from applying the standard to an individual contract. The TRG agenda paper noted that using a portfolio of data is not equivalent to using the portfolio approach practical expedient, so entities that use the expected value method to estimate variable consideration would not be required to assert that the outcome from the portfolio is not expected to materially differ from an assessment of individual contracts.

2.2.3 Constraining estimates of variable consideration

Before an entity can include any amount of variable consideration in the transaction price, it must consider whether the amount of variable consideration is required to be constrained. Applying the constraint is an integral part of the evaluation of the variable consideration and it applies to all types of variable consideration that must be estimated in all transactions. The Board explained in the Basis for Conclusions that it created this constraint on variable consideration to address concerns raised by many constituents that the standard could otherwise require recognition of revenue before there was sufficient certainty that the amounts recognised would faithfully depict the consideration to which an entity expects to be entitled in exchange for the goods or services transferred to a customer. [IFRS 15.BC203].

The IASB explained in the Basis for Conclusions that it did not intend to eliminate the use of estimates from the revenue recognition standard. Instead, it wanted to make sure the estimates are robust and result in useful information. [IFRS 15.BC204]. Following this objective, the Board concluded that it was appropriate to include estimates of variable consideration in revenue only when an entity has a ‘high degree of confidence’ that revenue will not be reversed in a subsequent reporting period. Therefore, the constraint is aimed at preventing the over-recognition of revenue (i.e. the standard focuses on potential significant reversals of revenue). The standard requires an entity to include in the transaction price some or all of an amount of variable consideration estimated only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved. [IFRS 15.56].

In making this assessment, an entity is required to consider both the likelihood and the magnitude of the revenue reversal. The standard includes factors that could increase the likelihood or the magnitude of a revenue reversal. These include, but are not limited to, any of the following: [IFRS 15.57]

1. ‘the amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgement or actions of third parties, weather conditions and a high risk of obsolescence of the promised good or service.
2. the uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
3. the entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.
4. the entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.
5. the contract has a large number and broad range of possible consideration amounts.’

The standard does have an exception ‘for consideration in the form of a sales or usage-based royalty that is promised in exchange for a licence of intellectual property.’ [IFRS 15.58].

To include variable consideration in the estimated transaction price, the entity has to conclude that it is ‘highly probable’ that a significant revenue reversal will not occur in future periods once the uncertainty related to the variable consideration is resolved. For the purpose of this analysis, the meaning of the term ‘highly probable’ is consistent with the existing definition in IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations, i.e. ‘significantly more likely than probable’. [IFRS 5 Appendix A]. For US GAAP preparers, ASC 606 uses the term ‘probable’ as the confidence threshold for applying the constraint, rather than ‘highly probable’, which is defined as ‘the future event or events are likely to occur’.6 However, the meaning of ‘probable’ under US GAAP is intended to be the same as ‘highly probable’ under IFRS. [IFRS 15.BC211].

Furthermore, the IASB noted that an entity’s analysis to determine whether its estimate of variable consideration should be constrained is largely qualitative. [IFRS 15.BC212]. That is, an entity needs to use judgement to evaluate whether it has met the objective of the constraint (i.e. it is highly probable that a significant revenue reversal will not occur in future periods) considering the factors provided in the standard that increase the probability of a significant revenue reversal (discussed further below). In addition, conclusions about amounts that may result in a significant revenue reversal may change as an entity satisfies a performance obligation.

An entity needs to consider both the likelihood and magnitude of a revenue reversal to apply the constraint.

• Likelihood – assessing the likelihood of a future reversal of revenue requires significant judgement. Entities want to ensure they adequately document the basis for their conclusions. The presence of any one of the indicators cited above does not necessarily mean that a reversal will occur if the variable consideration is included in the transaction price. The standard includes ‘factors’, rather than ‘criteria’, to signal that the list of items to consider is not a checklist for which all items need to be met. In addition, the factors provided are not meant to be an all-inclusive list and entities may consider additional factors that are relevant to their facts and circumstances.
• Magnitude – when assessing the probability of a significant revenue reversal, an entity is also required to assess the magnitude of that reversal. The constraint is based on the probability of a reversal of an amount that is ‘significant’ relative to the cumulative revenue recognised for the contract. When assessing the significance of the potential revenue reversal, the cumulative revenue recognised at the date of the potential reversal includes both fixed and variable consideration and includes revenue recognised from the entire contract, not just the transaction price allocated to a single performance obligation.

An entity must carefully evaluate the factors that could increase the likelihood or the magnitude of a revenue reversal, including those listed in paragraph 57 of IFRS 15:

• the amount of consideration is highly susceptible to factors outside the entity’s influence (e.g. volatility in a market, judgement or actions of third parties, weather conditions, high risk of obsolescence of the promised good or service);
• the uncertainty about the amount of consideration is not expected to be resolved for a long period of time;
• the entity’s experience (or other evidence) of similar types of contracts is limited, or that experience (or other evidence) has limited predictive value;
• the entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances; or
• the contract has a large number and broad range of possible consideration amounts.

There are some types of variable consideration that are frequently included in contracts that have significant uncertainties. It is likely to be more difficult for an entity to assert it is highly probable that these types of estimated amounts will not be subsequently reversed. Examples of the types of variable consideration include the following:

• payments contingent on regulatory approval (e.g. regulatory approval of a new drug);
• long-term commodity supply arrangements that are settled based on market prices at the future delivery date; or
• contingency fees based on litigation or regulatory outcomes (e.g. fees based on the positive outcome of litigation or the settlement of claims with government agencies).

When an entity determines that it cannot meet the highly probable threshold if it includes all of the variable consideration in the transaction price, the amount of variable consideration that must be included in the transaction price is limited to the amount that would not result in a significant revenue reversal. That is, the estimate of variable consideration is reduced until it reaches an amount that can be included in the transaction price that, if subsequently reversed when the uncertainty associated with the variable consideration is resolved, would not result in a significant reversal of cumulative revenue recognised. When there is significant uncertainty about the ultimate pricing of a contract, entities should not default to constraining the estimate of variable consideration to zero.

The standard includes an example in which the application of the constraint limits the amount of variable consideration included in the transaction price and one in which it does not. [IFRS 15.IE116-IE123].

In some situations, it is appropriate for an entity to include in the transaction price an estimate of variable consideration that is not a possible outcome of an individual contract. The TRG discussed this topic using the following example from the TRG agenda paper.7

When an entity uses the expected value method and determines that the estimated amount of variable consideration is not a possible outcome in the individual contract, the entity must still consider the constraint on variable consideration. Depending on the facts and circumstances of each contract, an entity may need to constrain its estimate of variable consideration, even though it has used an expected value method, if the factors in paragraph 57 of IFRS 15 indicate a likelihood of a significant revenue reversal. However, using the expected value method and considering probability-weighted amounts sometimes achieves the objective of the constraint on variable consideration. When an entity estimates the transaction price using the expected value method, the entity reduces the probability of a revenue reversal because the estimate does not include all of the potential consideration due to the probability weighting of the outcomes. In some cases, the entity may not need to constrain the estimate of variable consideration if the factors in paragraph 57 of IFRS 15 do not indicate a likelihood of a significant revenue reversal.

The standard provides the following example of a situation in which a qualitative analysis of the factors in paragraph 57 of IFRS 15 indicates that it is not highly probable that a significant reversal would not occur if an entity includes a performance-based incentive fee in the transaction price of an investment management contract. [IFRS 15.IE129-IE133].

See 3 below for a discussion of allocating the transaction price.

2.2.4 Reassessment of variable consideration

The standard specifies that at the end of each reporting period, an entity must ‘update the estimated transaction price (including updating its assessment of whether an estimate of variable consideration is constrained) to represent faithfully the circumstances present at the end of the reporting period and the changes in circumstances during the reporting period.’ The entity accounts for changes in the transaction price in accordance with paragraphs 87–90 of IFRS 15. [IFRS 15.59].

When a contract includes variable consideration, an entity needs to update its estimate of the transaction price throughout the term of the contract to depict conditions that exist at the end of each reporting period. This involves updating the estimate of the variable consideration (including any amounts that are constrained) to reflect an entity’s revised expectations about the amount of consideration to which it expects to be entitled, considering uncertainties that are resolved or new information that is gained about remaining uncertainties. As discussed at 2.2.3 above, conclusions about amounts that may result in a significant revenue reversal may change as an entity satisfies a performance obligation. See 3.5 below for a discussion of allocating changes in the transaction price after contract inception.

The IASB noted in the Basis for Conclusions that, in some cases, an estimate of variable consideration made at the end of an accounting period could be affected by information that arises after the end of the reporting period, but before the release of the financial statements. The Board decided not to include guidance in IFRS 15 on accounting in these situations, because it noted that the accounting for subsequent events is already addressed in IAS 10 – Events after the Reporting Period (see Chapter 38). [IFRS 15.BC228].

2.4.1 Is an entity applying the portfolio approach practical expedient when accounting for rights of return?

An entity can, but would not be required to, apply the portfolio approach practical expedient to estimate variable consideration for expected returns using the expected value method. Similar to the discussion at 2.2.2 above on estimating variable consideration, the July 2015 TRG agenda paper noted that an entity can consider evidence from other, similar contracts to develop an estimate of variable consideration using the expected value method without applying the portfolio approach practical expedient. In order to estimate variable consideration in a contract, an entity frequently makes judgements considering its historical experience with other, similar contracts. Considering historical experience does not necessarily mean the entity is applying the portfolio approach practical expedient.11

This question arises, in part, because Example 22 in IFRS 15 (see Example 29.11 at 2.4 above) states that the entity is using the portfolio approach practical expedient in paragraph 4 of IFRS 15 to calculate its estimate of returns. Use of this practical expedient requires an entity to assert that it does not expect the use of the expedient to differ materially from applying the standard to an individual contract.

We expect that entities often use the expected value method to estimate variable consideration related to returns because doing so would likely better predict the amount of consideration to which the entities will be entitled. This is despite the fact that there are two potential outcomes for each contract from the variability of product returns: the product either will be returned or will not be returned. That is, the revenue for each contract ultimately either will be 100% or will be 0% of the total contract value (assuming returns create the only variability in the contract). However, entities may conclude that the expected value is the appropriate method for estimating variable consideration because they have a large number of contracts with similar characteristics. The TRG agenda paper noted that using a portfolio of data is not equivalent to using the portfolio approach practical expedient, so entities that use the expected value method to estimate variable consideration for returns would not be required to assert that the outcome from the portfolio is not expected to materially differ from an assessment of individual contracts.

2.4.2 Accounting for restocking fees for goods that are expected to be returned

Entities sometimes charge customers a ‘restocking fee’ when a product is returned. This fee may be levied by entities to compensate them for the costs of repackaging, shipping and/or reselling the item at a lower price to another customer. Stakeholders had raised questions about how to account for restocking fees and related costs.12

At the July 2015 TRG meeting, the TRG members generally agreed that restocking fees for goods that are expected to be returned would be included in the estimate of the transaction price at contract inception and recorded as revenue when (or as) control of the good transfers. That is, selling a product subject to a restocking fee if it is returned is not different from providing a partial return right and should be accounted for similarly.

2.4.3 Accounting for restocking costs for goods that are expected to be returned

At the July 2015 TRG meeting, the TRG members generally agreed that restocking costs (e.g. shipping and repackaging costs) would be recorded as a reduction of the amount of the return asset when (or as) control of the good is transferred to the customer. This accounting treatment is consistent with the requirement in paragraph B25 of IFRS 15 that the return asset be initially measured at the former carrying amount of the inventory, less any expected costs to recover the goods (e.g. restocking costs).13

2.5.1 Examples of significant financing components

The standard includes several examples to illustrate these concepts. Example 29.13 illustrates a contract that contains a significant financing component because the cash selling price at contract inception differs from the promised amount of consideration payable after delivery and there are no other factors present that would indicate that this difference arises for reasons other than financing. In this example, the implicit interest rate in the contract is determined to be commensurate with the rate that would be reflected in a separate financing transaction between the entity and its customer at contract inception. [IFRS 15.IE135-IE140].

Example 29.13 also illustrates the requirement in paragraph 65 of IFRS 15, which provides that interest income or interest expense is recognised only to the extent that a contract asset (or receivable) or a contract liability is recognised in accounting for a contract with a customer. See further discussion in 2.5.3 below.

In Example 29.14, the difference between the promised consideration and the cash selling price of the good or service arises for reasons other than the provision of financing. In this example, the customer withholds a portion of each payment until the contract is complete in order to protect itself from the entity failing to complete its obligations under the contract, as follows. [IFRS 15.IE141-IE142].

Example 29.15 illustrates two situations. [IFRS 15.IE143-IE147]. In Case A, a contractual discount rate reflects the rate in a separate financing transaction. In Case B, it does not.

Example 29.16 illustrates a contract with an advance payment from the customer that the entity concludes represents a significant benefit of financing. It also illustrates a situation in which the implicit interest rate does not reflect the interest rate that would be used in a separate financing transaction between the entity and its customer at contract inception, as follows. [IFRS 15.IE148-IE151].

In Example 29.17, involving a contract with an advance payment from the customer, the entity determines that a significant financing component does not exist because the difference between the amount of promised consideration and the cash selling price of the good or service arises for reasons other than the provision of financing, as follows. [IFRS 15.IE152-IE154].

2.5.2 Application questions on identifying and accounting for significant financing components

See Chapter 28 at 3.6.1.K for discussion on whether an entity is required to evaluate if a customer option that provides a material right includes a significant financing component.

2.5.3 Financial statement presentation of financing component

As discussed at 2.5 above, when a significant financing component exists in a contract, the transaction price is adjusted so that the amount recognised as revenue is the ‘cash selling price’ of the underlying goods or services at the time of transfer. Essentially, a contract with a customer that has a significant financing component would be separated into a revenue component (for the notional cash sales price) and a loan component (for the effect of the deferred or advance payment terms). [IFRS 15.BC244]. Consequently, the accounting for accounts receivable arising from a contract that has a significant financing component should be comparable to the accounting for a loan with the same features. [IFRS 15.BC244].

The amount allocated to the significant financing component would have to be presented separately from revenue recognised from contracts with customers. The financing component is recognised as interest expense (when the customer pays in advance) or interest income (when the customer pays in arrears). The interest income or expense is recognised over the financing period using the effective interest method described in IFRS 9. The standard notes that interest is only recognised to the extent that a contract asset, contract liability or receivable is recognised in accordance with IFRS 15. [IFRS 15.65].

As discussed in Chapter 32 at 2.1, a contract asset (or receivable) or contract liability is generated (and presented on the balance sheet) when either party to a contract performs, depending on the relationship between the entity’s performance and the customer’s payment. Example 29.13 (see 2.5.1 above) illustrates a situation in which an entity transfers control of a good to a customer, but the customer is not required to pay for the good until two years after delivery. The contract includes a significant financing component.

Furthermore, the customer has the right to return the good for 90 days. The product is new and the entity does not have historical evidence of returns activity. Therefore, the entity is not able to recognise revenue (or a contract asset or receivable) upon delivery because it cannot assert that it is highly probable that a significant revenue reversal will not occur (i.e. it cannot assert that it is highly probable that the product will not be returned). Accordingly, during the 90-day return period, the entity also cannot record interest income. However, as depicted in the example, once the return period lapses, the entity can record revenue and a receivable, as well as begin to recognise interest income.

The IASB noted in the Basis for Conclusions that an entity may present interest income as revenue only when interest income represents income from an entity’s ordinary activities. [IFRS 15.BC247].

Although there are two components within the transaction price when there is a significant financing component (i.e. the revenue component and the significant financing component), it is only in the case of deferred payment terms that there are two cash flow components. In that case, the revenue component cash flows should be classified as cash flows from operating activities, and the cash flows related to the significant financing component should be classified consistent with the entity’s choice to present cash flows from interests received/paid in accordance with paragraph 33 of IAS 7 – Statement of Cash Flows – (i.e. as cash flows from operating or investing/financing activities). If the customer pays in advance, the sum of the cash amount and the accrued interest represent revenue, and thus there is only one cash flow component. Accordingly, the cash received should be classified as cash flows from operating activities.

Impairment losses on receivables, with or without a significant financing component, are presented in line with the requirements of IAS 1 – Presentation of Financial Statements – and disclosed in accordance with IFRS 7 – Financial Instruments: Disclosures. However, IFRS 15 makes it clear that such amounts are ‘disclosed separately from impairment losses from other contracts.’ [IFRS 15.113(b)].

We believe entities may need to expend additional effort to track impairment losses on assets arising from contracts that are within the scope of IFRS 15 separately from impairment losses on assets arising from other contracts. Entities need to ensure that they have the appropriate systems, internal controls, policies and procedures in place to collect and separately present this information.

2.6.1 Non-cash consideration application considerations

Stakeholders raised questions about the date that should be used when measuring the fair value of non-cash consideration for inclusion within the transaction price. In addition, constituents noted that the variability of non-cash consideration could arise both from its form (e.g. shares) and for other reasons (e.g. performance factors that affect the amount of consideration to which the entity will be entitled). Consequently, they questioned how the constraint on variable consideration would be applied in such circumstances.

At the January 2015 TRG meeting, the TRG members discussed these questions and agreed that, while the standard requires non-cash consideration (e.g. shares, advertising provided as consideration from a customer) to be measured at fair value, it is unclear when that fair value must be measured (i.e. the measurement date). The TRG members discussed three measurement date options: contract inception; when it is received; or when the related performance obligation is satisfied. Each view received support from some TRG members. Since IFRS 15 does not specify the measurement date, an entity needs to use its judgement to determine the most appropriate measurement date when measuring the fair value of non-cash consideration. However, in accordance with paragraph 126 of IFRS 15, information about the methods, inputs and assumptions used to measure non-cash consideration needs to be disclosed. [IFRS 15.BC254E].

IFRS 15 requires that the constraint on variable consideration be applied to non-cash consideration only if the variability is due to factors other than the form of consideration (i.e. variability arising for reasons other than changes in the price of the non-cash consideration). The constraint does not apply if the non-cash consideration varies because of its form (e.g. listed shares for which the share price changes). However, the standard does not address how the constraint would be applied when the non-cash consideration is variable due to both its form and other reasons. While some of the TRG members said the standard could be interpreted to require an entity to split the consideration based on the source of the variability, other TRG members highlighted that this approach would be overly complex and would not provide useful information.

The FASB’s standard specifies that the fair value of non-cash consideration needs to be measured at contract inception when determining the transaction price. Any subsequent changes in the fair value of the non-cash consideration due to its form (e.g. changes in share price) are not included in the transaction price and would be recognised, if required, as a gain or loss in accordance with other accounting standards, but would not be recognised as revenue from contracts with customers. However, in the Basis for Conclusions, the IASB observed that this issue has important interactions with other standards (including IFRS 2 and IAS 21) and there was a concern about the risk of unintended consequences. Therefore, the Board decided that, if needed, these issues would be considered more comprehensively in a separate project. [IFRS 15.BC254C]. The IASB acknowledged in the Basis for Conclusions, that the use of a measurement date other than contract inception would not be precluded under IFRS. Consequently, it is possible that diversity between IFRS and US GAAP entities may arise in practice. Unlike US GAAP, legacy IFRS did not contain specific requirements regarding the measurement date for non-cash consideration related to revenue transactions. As such, the IASB does not expect IFRS 15 to create more diversity than previously existed in relation to this issue. [IFRS 15.BC254E].

The FASB’s standard also specifies that when the variability of non-cash consideration is due to both the form of the consideration and for other reasons, the constraint on variable consideration would apply only to the variability for reasons other than its form. While IFRS 15 does not have a similar requirement, the Board noted in the Basis for Conclusions that it decided to constrain variability in the estimate of the fair value of the non-cash consideration if that variability relates to changes in the fair value for reasons other than the form of the consideration. It also noted the view of some TRG members that, in practice, it might be difficult to distinguish between variability in the fair value due to the form of the consideration and other reasons, in which case applying the variable consideration constraint to the whole estimate of the non-cash consideration might be more practical. [IFRS 15.BC252]. However, for reasons similar to those on the measurement date for non-cash consideration, the IASB decided not to have a similar requirement to that of the FASB’s standard. Consequently, the IASB acknowledged that differences may arise between an entity reporting under IFRS and an entity reporting under US GAAP. [IFRS 15.BC254H].

2.6.2 Barter transactions

An entity may enter into barter transactions to provide goods or services in exchange for receiving similar or dissimilar goods or services from its customers. In some cases, barter transactions may include cash consideration in addition to the non-cash consideration. Therefore, significant judgement and consideration of the specific facts and circumstances will be needed when accounting for such transactions.

Aspects of the standard that will be particularly important to consider include, but are not limited to:

• Understanding whether the transaction is within the scope of the standard – barter transactions involve non-monetary exchanges. Therefore, an entity first needs to determine whether the barter transaction involves a non-monetary exchange between entities in the same line of business to facilitate sales to (potential) customers. If it does, it is excluded from the scope of IFRS 15 (see Chapter 27 at 3.1.1). For barter transactions not subject to this scope exclusion (i.e. they are within the scope of IFRS 15), an entity needs to understand whether there is vendor-customer relationship with the counterparty and whether the transaction is in the ordinary course of its business. This is because IFRS 15 only applies to contracts that provide goods or services to customers in the ordinary course of business (see Chapter 27 at 3.1 and 3.3).
• Determining whether the transaction has commercial substance (such that the contract meets the criteria to be considered a contract under the five-step model in IFRS 15) – exchanging goods or services in a barter transaction may lack commercial substance. An entity needs to determine whether the risk, timing or amount of an entity’s future cash flows change as a result of the barter transaction (see Chapter 28 at 2.1.5).
• Identifying the promised goods or services to be transferred to the customer – barter transactions may involve the exchange of a good or service, but not necessarily the transfer of its control. An entity needs to understand whether the customer will obtain control of a good or service (see Chapter 30). That is, whether there is a promised good or service in the contract (see Chapter 28 at 3.1).
• Determining whether the entity will obtain control of any non-cash consideration – barter transactions involve the exchange of non-cash items. Only non-cash items of which the entity obtains control from the customer would be non-cash consideration for purposes of applying the standard (as noted above).
• Determining the fair value of any non-cash consideration received from the customer (see 2.6 above) – in order to recognise revenue in the barter transaction, the non-cash consideration obtained from a customer needs to be measured either: (a) directly, at its fair value if it can be reasonably estimated; or (b) indirectly, by reference to the stand-alone selling price of the promised good or service transferred to the customer if the fair value of the non-cash consideration cannot be reasonably estimated. IFRS 15 does not permit an entity to avoid recognising revenue if the fair value cannot be estimated reliably. Therefore, if the transaction is within the scope of IFRS 15, revenue must be recognised.

2.7.1 Determining who is an entity’s customer when applying the requirements for consideration payable to a customer

When applying the requirements for consideration payable to a customer, it is important to determine who is an entity’s customer. This was considered by the TRG members at both the March 2015 and July 2015 TRG meetings.

The TRG members generally agreed that the requirements for consideration payable to a customer apply to all payments made to entities/customers in the distribution chain for that contract. However, they agreed that there could also be situations in which the requirements would apply to payments made to any customer of an entity’s customer outside the distribution chain if both parties are considered the entity’s customers. For example, in an arrangement with a principal, an agent and an end-customer, an agent may conclude that its only customer is the principal or it may conclude that it has two customers – the principal and the end-customer. Regardless of this assessment, an agent’s payment to a principal’s end-customer that was contractually required based on an agreement between the entity (agent) and the principal would represent consideration payable to a customer. Absent similar contract provisions that clearly indicate when an amount is consideration payable, the TRG members agreed that agents need to evaluate their facts and circumstances to determine whether payments made to an end-customer would be considered a reduction of revenue or a marketing expense.26

2.7.2 Forms of consideration paid or payable to a customer

Consideration paid or payable to customers commonly takes the form of discounts and coupons, among others. Furthermore, the promise to pay the consideration may be implied by the entity’s customary business practice, as stated in paragraph 72 of IFRS 15. [IFRS 15.72].

Since consideration paid or payable to a customer can take many different forms, entities have to carefully evaluate each transaction to determine the appropriate treatment of such amounts (i.e. as payment for a distinct good or service, a reduction of the transaction price or a combination of both as illustrated in Figure 29.2 at 2.7). Some common examples of consideration paid to customers are given below.

• Slotting fees – Manufacturers of consumer products commonly pay retailers fees to have their goods displayed prominently on store shelves. Generally, such fees do not provide a distinct good or service to the manufacturer and are treated as a reduction of the transaction price.
• Co-operative advertising arrangements – In some arrangements, an entity agrees to reimburse a reseller for a portion of costs incurred by the reseller to advertise the entity’s products. The determination of whether the payment from the vendor is in exchange for a distinct good or service at fair value depends on a careful analysis of the facts and circumstances of the contract.
• Price protection – An entity may agree to reimburse a retailer up to a specified amount for shortfalls in the sales price received by the retailer for the entity’s products over a specified period of time. Normally such fees do not provide a distinct good or service to the manufacturer and are treated as a reduction of the transaction price (see 2.2.1.E above).
• Coupons and rebates – An indirect customer of an entity may receive a refund of a portion of the purchase price of the product or service acquired by returning a form to the retailer or the entity. Generally, such fees do not provide a distinct good or service to the manufacturer and are treated as a reduction of the transaction price.
• ‘Pay-to-play’ arrangements – In some arrangements, an entity pays an upfront fee to the customer prior to, or in conjunction with, entering into a contract. In most cases, these payments are not associated with any distinct good or service to be received from the customer and are treated as a reduction of the transaction price.
• Purchase of goods or services – Entities often enter into supplier-vendor arrangements with their customers in which the customers provide them with a distinct good or service. For example, a software entity may buy its office supplies from one of its software customers. In such situations, the entity has to carefully determine whether the payment made to the customer is solely for the goods or services received, or whether part of the payment is actually a reduction of the transaction price for the goods or services the entity is transferring to the customer.

In 2018, the FASB issued an amendment to simplify the accounting for share-based payment awards to non-employees, including an amendment to ASC 606 to clarify that equity instruments granted to customers in conjunction with selling goods or services (e.g. shares, options) are within the scope of the requirements for consideration payable to customers.27 The IASB has not proposed any similar amendments to IFRS 15. Therefore, entities applying IFRS could reach different accounting conclusions from those applying US GAAP. For further discussion, see Chapter 27 at 3.5.1.L.

In 2019, the FASB issued another amendment that requires entities to measure and classify share-based payment awards (both equity-classified and liability-classified) granted to a customer in a revenue arrangement and are not in exchange for a distinct good or service in accordance with ASC 718 – Compensation – Stock Compensation.28 The IASB has not proposed any similar amendments to IFRS 15.

2.7.3 Classification and measurement of consideration paid or payable to a customer

To determine the appropriate accounting treatment (and as illustrated in Figure 29.2 at 2.7 above), an entity must first determine whether the consideration paid or payable to a customer is a payment for a distinct good or service. If it is not in exchange for a distinct good or service, an entity accounts for consideration payable to a customer as a reduction in the transaction price. This is because paragraph 70 of IFRS 15 states that ‘an entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment is for a distinct good or service’ (see 2.7 above). [IFRS 15.70]. That is, for a payment by the entity to a customer to be treated as something other than a reduction of the transaction price, the good or service provided by the customer must be distinct (as discussed in Chapter 28 at 3.2.1).

If it is in exchange for a distinct good or service at fair value, an entity accounts for consideration payable to a customer in the same way it accounts for other purchases from suppliers. However, as noted in paragraph 71 of IFRS 15, if the payment to the customer is in excess of the fair value of the distinct good or service received, the entity must account for such excess as a reduction of the transaction price. In the event that the entity cannot reasonably estimate the fair value of the good or service received from the customer, it will need to account for all of the consideration payable to the customer as a reduction in the transaction price. [IFRS 15.71].

In many cases, determining the amount of consideration payable to a customer (e.g. cash amounts an entity pays to a customer) will be straightforward. However, if the consideration paid or payable to a customer includes a variable amount, paragraph 70 of IFRS 15 notes that an entity would estimate the amount using the variable consideration requirements in paragraphs 50-58 of IFRS 15 (see 2.2 above). [IFRS 15.70].

2.7.4 Timing of recognition of consideration paid or payable to a customer

If the consideration paid or payable to a customer accounted for as a reduction of the transaction price, paragraph 72 of IFRS 15 states that this reduction of the transaction price (and, ultimately, revenue) is recognised at the later of when: (1) the entity recognises revenue for the transfer of the related promised goods or services to the customer; or (2) the entity pays or promises to pay the consideration (even if the payment is conditional on a future event) (see 2.7 above). [IFRS 15.72]. For example, if goods subject to a discount through a coupon are already delivered to the retailers, the discount would be recognised when the coupons are issued. However, if a coupon is issued that can be used on a new line of products that have not yet been sold to retailers, the discount would be recognised upon sale of the products to a retailer. Paragraph 82(b) of IFRS 15 also notes that the promise to pay the consideration might be implied by an entity’s customary business practices. [IFRS 15.82(b)].

Certain sales incentives, such as mail-in rebates and manufacturer coupons, entitle a customer to receive a reduction in the price of goods or services by submitting a form or claim for a refund of a specified amount of the price charged to the customer at the point of sale. An entity must recognise a liability for those sales incentives at the later of: (a) when it recognises revenue on the goods or services; or (b) the date at which the sales incentive was offered. The amount of liability will be based on the estimated amount of discounts or refunds that will be claimed by customers, similar to how the entity would estimate variable consideration (see 2.2.2 above).

Even if the sales incentives would result in a loss on the sale of the product or service, an entity would also recognise a liability for those sales incentives at the later of: (a) when it recognises revenue on the goods or services; or (b) the date at which the sales incentive was offered. That is, an entity would not recognise the loss before either date. However, an entity would need to consider whether the offer indicates that the net realisable value of inventories are lower than costs which will require write-down of inventories to net realisable value. [IAS 2.9, IAS 2.28].

To determine the appropriate timing of recognition of consideration payable to a customer, entities also need to consider the requirements for variable consideration. That is, the standard’s description of variable consideration is broad and includes amounts such as coupons or other forms of credits that can be applied to the amounts owed to an entity by the customer (see 2.2.1 above). IFRS 15 requires that all potential variable consideration be considered and reflected in the transaction price at contract inception and reassessed as the entity performs. In other words, if an entity has a history of providing this type of consideration to its customers, the requirements on estimating variable consideration would require that such amounts be considered at contract inception, even if the entity has not yet provided or explicitly promised this consideration to the customer.

The TRG discussed the potential inconsistency that arises between the requirements on consideration payable to a customer and variable consideration, as the requirements specific to consideration payable to a customer indicate that such amounts are not recognised as a reduction of revenue until the later of when:

• the related sales are recognised, or
• the entity promises to provide such consideration.30

A literal read of these requirements seems to suggest that an entity need not anticipate offering these types of programmes, even if it has a history of doing so, and would only recognise the effect of these programmes at the later of when the entity transfers the promised goods or services or makes a promise to pay the customer. The TRG members generally agreed that if an entity has historically provided or intends to provide this type of consideration to customers, the requirements on estimating variable consideration (i.e. paragraphs 50-52 of IFRS 15) would require the entity to consider such amounts at contract inception when the transaction price is estimated, even if the entity has not yet provided or promised to provide this consideration to the customer.31 If the consideration paid or payable to a customer includes variable consideration (e.g. in the form of a discount or refund for goods or services provided), an entity would use either the expected value method or most likely amount method to estimate the amount to which the entity expects to be entitled and apply the constraint to the estimate (see 2.2.3 above for further discussion) to determine the effect of the variable consideration payable to the customer.

There was general agreement by TRG members that entities need to consider the requirements for variable consideration to determine the appropriate timing of recognition of consideration payable to a customer. Therefore, significant judgement may be needed to determine the appropriate timing of recognition.

The standard includes the following example of consideration paid to a customer. [IFRS 15.IE160-IE162].

2.8.1 Application questions on non-refundable upfront fees

See Chapter 28 at 2.2.1.E for a discussion on how consideration received from a customer, but not yet recognised as revenue, is accounted for when the contract is cancelled.

3.1.1 Factors to consider when estimating the stand-alone selling price

To estimate the stand-alone selling price (if not readily observable), an entity may consider the stated prices in the contract. However, the standard says an entity cannot presume that a contractually stated price, or a list price, for a good or service is the stand-alone selling price. [IFRS 15.77]. In estimating a stand-alone selling price, an ‘entity shall consider all information (including market conditions, entity-specific factors and information about the customer or class of customer) that is reasonably available to the entity’. [IFRS 15.78]. An entity also needs to maximise the use of observable inputs in its estimate. This is a very broad requirement for which an entity needs to consider a variety of data sources.

The following list, which is not all-inclusive, provides examples of market conditions to consider:

• potential limits on the selling price of the product;
• competitor pricing for a similar or identical product;
• market awareness and perception of the product;
• current market trends that are likely to affect the pricing;
• the entity’s market share and position (e.g. the entity’s ability to dictate pricing);
• effects of the geographic area on pricing;
• effects of customisation on pricing; or
• expected life of the product, including whether significant technological advances are expected in the market in the near future.

Examples of entity-specific factors include:

• profit objectives and internal cost structure;
• pricing practices and pricing objectives (including desired gross profit margin);
• effects of customisation on pricing;
• pricing practices used to establish pricing of bundled products;
• effects of a proposed transaction on pricing (e.g. the size of the deal, the characteristics of the targeted customer); or
• expected life of the product, including whether significant entity-specific technological advances are expected in the near future.

To document its estimated stand-alone selling price, an entity should consider describing the information that it has considered (e.g. the factors listed above), especially if there is limited observable data or none at all.

3.1.2 Possible estimation approaches

Paragraph 79 of IFRS 15 discusses three estimation approaches: (1) the adjusted market assessment approach; (2) the expected cost plus a margin approach; and (3) a residual approach. [IFRS 15.79]. All of these are discussed further below. When applying IFRS 15, an entity may need to use a different estimation approach for each of the distinct goods or services underlying the performance obligations in a contract. In addition, an entity may need to use a combination of approaches to estimate the stand-alone selling prices of goods or services promised in a contract if two or more of those goods or services have highly variable or uncertain stand-alone selling prices.

Furthermore, these are not the only estimation approaches permitted. IFRS 15 allows any reasonable estimation approach: as long as it is consistent with the notion of a stand-alone selling price; maximises the use of observable inputs and is applied on a consistent basis for similar goods or services and customers. [IFRS 15.80].

In some cases, an entity may have sufficient observable data to determine the stand-alone selling price. For example, an entity may have sufficient stand-alone sales of a particular good or service that provide persuasive evidence of the stand-alone selling price of that particular good or service. In such situations, no estimation would be necessary. [IFRS 15.77].

In many instances, an entity may not have sufficient stand-alone sales data to determine the stand-alone selling price based solely on those sales. In those instances, it must maximise the use of whatever observable inputs it has available in order to make its estimate. That is, an entity would not disregard any observable inputs when estimating the stand-alone selling price of a good or service. [IFRS 15.78]. An entity should consider all factors contemplated in negotiating the contract with the customer and the entity’s normal pricing practices factoring in the most objective and reliable information that is available. While some entities may have robust practices in place regarding the pricing of goods or services, some may need to improve their processes to develop estimates of stand-alone selling prices.

The standard includes the following estimation approaches. [IFRS 15.79].

• Adjusted market assessment approach – this approach focuses on the amount that the entity believes the market in which it sells goods or services is willing to pay for a good or service. For example, an entity might refer to competitors’ prices for similar goods or services and adjust those prices, as necessary, to reflect the entity’s costs and margins. When using the adjusted market assessment approach, an entity considers market conditions, such as those listed at 3.1.1 above. Applying this approach is likely to be easiest when an entity has sold the good or service for a period of time (such that it has data about customer demand), or a competitor offers similar goods or services that the entity can use as a basis for its analysis. Applying this approach may be difficult when an entity is selling an entirely new good or service because it may be difficult to anticipate market demand. In these situations, entities may want to use the market assessment approach, with adjustments as necessary, to reflect the entity’s costs and margins, in combination with other approaches to maximise the use of observable inputs (e.g. using competitors’ pricing, adjusted based on the market assessment approach in combination with an entity’s planned internal pricing strategies if the performance obligation has never been sold separately).
• Expected cost plus margin approach – this approach focuses more on internal factors (e.g. the entity’s cost basis), but has an external component as well. That is, the margin included in this approach must reflect the margin the market would be willing to pay, not just the entity’s desired margin. The margin may have to be adjusted for differences in products, geographies, customers and other factors. The expected cost plus margin approach may be useful in many situations, especially when the performance obligation has a determinable direct fulfilment cost (e.g. a tangible product or an hourly service). However, this approach may be less helpful when there are no clearly identifiable direct fulfilment costs or the amount of those costs is unknown (e.g. a new software licence or specified upgrade rights).
• Residual approach – this approach allows an entity to estimate the stand-alone selling price of a promised good or service as the difference between the total transaction price and the observable (i.e. not estimated) stand-alone selling prices of other promised goods or services in the contract, provided one of two criteria in paragraph 79(c) of IFRS 15 are met. [IFRS 15.79(c)]. The standard indicates that this approach can only be used for contracts with multiple promised goods or services when the selling price of one or more of the promised goods or services is unknown (either because the historical selling price is highly variable or because the goods or services have not yet been sold). As a result, we expect that the use of this approach is likely to be limited. However, allowing entities to use a residual technique provides relief to entities that rarely, or never, sell goods or services on a stand-alone basis, such as entities that sell intellectual property only with physical goods or services.

  The Board noted in the Basis for Conclusions that the use of the residual approach cannot result in a stand-alone selling price of zero if the good or service is distinct. [IFRS 15.BC273]. This is because a good or service must have value on a stand-alone basis to be distinct. The Board also stated that, if use of the residual approach results in very little, or no, consideration being allocated to a good or service or a bundle of goods or services, an entity should re-evaluate whether the use of the residual approach is appropriate.

  An example of an appropriate use of the residual approach would be an entity that frequently sells software, professional services and maintenance, bundled together, at prices that vary widely. However, the entity also sells the professional services and maintenance individually at relatively stable prices. The Board indicated that it may be appropriate to estimate the stand-alone selling price for the software as the difference between the total transaction price and the observable selling prices of the professional services and maintenance. See Cases B and C in Example 29.30, at 3.4 below, for examples of when the residual approach may or may not be appropriate.

  The Board clarified in the Basis for Conclusions that an entity could also use the residual approach if there are two or more goods or services in the contract with highly variable or uncertain stand-alone selling prices, provided that at least one of the other promised goods or services in the contract has an observable stand-alone selling price. The Board observed that, in such an instance, an entity may need to use a combination of techniques to estimate the stand-alone selling prices. [IFRS 15.BC272]. For example, an entity may apply the residual approach to estimate the aggregate of the stand-alone selling prices for all of the promised goods or services with highly variable or uncertain stand-alone selling prices, but then use another approach (e.g. adjusted market assessment, expected cost plus margin) to estimate the stand-alone selling prices of each of those promised goods or services with highly variable or uncertain stand-alone selling prices.

The standard includes the following example in which two estimation approaches are used to estimate stand-alone selling prices of two different goods in a contract. [IFRS 15.IE164-IE166].

Given the flexibility provided by the standard to estimate stand-alone selling prices, it is both appropriate and necessary for entities to tailor the approach(es) used to their specific facts and circumstances. However, regardless of whether the entity uses a single approach or a combination of approaches, it must evaluate whether the resulting allocation of the transaction price is consistent with the overall allocation objective in paragraph 73 of IFRS 15 and the requirements for estimating stand-alone selling prices. [IFRS 15.80].

In accordance with IFRS 15, an entity must make a reasonable estimate of the stand-alone selling price for the distinct good or service underlying each performance obligation if an observable selling price is not readily available. We believe entities should have sufficient information to develop a reasonable estimate, even in instances in which limited information is available.

Entities need robust processes to estimate stand-alone selling prices. If those estimates have limited underlying observable data, it is important for entities to be able to demonstrate the reasonableness of the calculations they make in estimating stand-alone selling prices.

3.1.3 Updating estimated stand-alone selling prices

As discussed at 3.1 above, stand-alone selling prices are determined at contract inception and are not updated to reflect changes between contract inception and when performance is complete. However, an entity needs to update its estimates of stand-alone selling prices for future transactions to reflect changes in circumstances.

IFRS 15 does not specifically address how frequently estimated stand-alone selling prices must be updated. Instead, it indicates that an entity must make this estimate for each distinct good or service underlying each performance obligation in each contract with a customer, which suggests that an entity needs to constantly update its estimates.

In practice, we expect that entities will be able to consider their own facts and circumstances in order to determine how frequently they will need to update their estimates. If, for example, the information used to estimate the stand-alone selling price for similar transactions has not changed, an entity may determine that it is reasonable to use the previously determined stand-alone selling price.

However, in order for the changes in circumstances to be reflected in the estimate in a timely manner, we expect that an entity would formally update the estimate on a regular basis (e.g. monthly, quarterly, semi-annually). The frequency of updates should be based on the facts and circumstances of the distinct good or service underlying each performance obligation for which the estimate is made. An entity uses current information each time it develops or updates its estimate. While the estimates may be updated, the approach used to estimate a stand-alone selling price does not change (i.e. an entity must use a consistent approach), unless facts and circumstances change. [IFRS 15.78].

3.1.4 Additional considerations for determining the stand-alone selling price

While not explicitly stated in IFRS 15, we expect that a single good or service could have more than one stand-alone selling price. That is, the entity may be willing to sell goods or services at different prices to different customers. Furthermore, an entity may use different prices in different geographies or in markets where it uses different methods to distribute its products (e.g. it may use a distributor or reseller, rather than selling directly to the end-customer) or for other reasons (e.g. different cost structures or strategies in different markets). Accordingly, an entity may need to stratify its analysis to determine its stand-alone selling price for each class of customer, geography and/or market, as applicable.

3.1.5 Measurement of options that are separate performance obligations

An entity that determines that a customer option for additional goods or services is a separate performance obligation (because the option provides the customer with a material right, as discussed at Chapter 28 at 3.6) needs to determine the stand-alone selling price of the option. [IFRS 15.B42].

If the option’s stand-alone selling price is not directly observable, the entity needs to estimate it. In doing so, paragraph B42 of IFRS 15 requires an entity to take into consideration any discount the customer would receive in a stand-alone transaction and the likelihood that the customer would exercise the option. [IFRS 15.B42]. Generally, option pricing models consider both the intrinsic value of the option (i.e. the value of the option if it were exercised today) and its time value (e.g. the option may be more or less valuable based on the amount of time until its expiration date and/or the volatility of the price of the underlying good or service). However, an entity is only required to measure the intrinsic value of the option when estimating the stand-alone selling price of the option. In the Basis for Conclusions, the Board noted that the benefits of valuing the time value component of an option would not justify the cost of doing so. [IFRS 15.BC390]. Example 28.43 in Chapter 28 at 3.6 illustrates the measurement of an option determined to be a material right under paragraph B42 of IFRS 15. The following example also illustrates this concept:

Paragraph B43 of IFRS 15 provides an alternative to estimating the stand-alone selling price of an option. This practical alternative applies when the additional goods or services are both: (1) similar to the original goods or services in the contract (i.e. the entity continues to provide what it was already providing); [IFRS 15.BC394] and (2) provided in accordance with the terms of the original contract. The standard indicates that this practical alternative generally applies to options for contract renewals (i.e. the renewal option approach). [IFRS 15.B43].

The Basis for Conclusions states that customer loyalty points and discount vouchers typically do not meet the criteria for use of this practical alternative. This is because customer loyalty points and discount vouchers are redeemable for goods or services that may differ in nature from those offered in the original contract and the terms of the original contract do not restrict the pricing of the additional goods or services. For example, if an airline offers flights to customers in exchange for points from its frequent flyer programme, the airline is not restricted because it can subsequently determine the number of points that are required to be redeemed for any particular flight. [IFRS 15.BC 394, BC395].

Under the practical alternative, a portion of the transaction price is allocated to the option (i.e. the material right that is a performance obligation) by reference to the total goods or services expected to be provided to the customer (including expected renewals) and the corresponding expected consideration. That is, the total amount of consideration expected to be received from the customer (including consideration from expected renewals) is allocated to the total goods or services expected to be provided to the customer, including those from the expected contract renewals. The amount allocated to the goods or services that the entity is required to transfer to the customer under the contract (i.e. excluding the optional goods or services that will be transferred if the customer exercises the renewal option(s)) is then subtracted from the total amount of consideration received (or that will be received) for transferring those goods or services. The difference is the amount that is allocated to the option at contract inception. An entity using this alternative needs to apply the constraint on variable consideration (as discussed at 2.2.3 above) to the estimated consideration for the optional goods or services prior to performing the allocation (see Example 29.24, Scenario B, below). [IFRS 15.B43].

It is important to note that the calculation of total expected consideration (i.e. the hypothetical transaction price), including consideration related to expected renewals, is only performed for the purpose of allocating a portion of the hypothetical transaction price to the option at contract inception. It does not change the enforceable rights or obligations in the contract, nor does it affect the actual transaction price for the goods or services that the entity is presently obliged to transfer to the customer (which would not include expected renewals). Accordingly, the entity would not include any remaining hypothetical transaction price in its disclosure of remaining performance obligations (see Chapter 32 at 3.2.1.C). In this respect, the practical alternative is consistent with the conclusion in Chapter 28 at 3.6.1.D. That is, even if an entity may think that it is almost certain that a customer will exercise an option to buy additional goods or services, an entity does not include the additional goods or services underlying the option as promised goods or services (or performance obligations), unless there are substantive contractual penalties.

Subsequent to contract inception, if the actual number of contract renewals is different from an entity’s initial expectations, the entity updates the hypothetical transaction price and allocation. However, as discussed at 3.1 above, the estimate of the stand-alone selling price at contract inception is not updated. See Example 29.24, Scenario B below for an example of how an entity could update its practical alternative calculation based on a change in expectations.

The following example illustrates the two possible approaches for measuring options included in a contract.

3.2.1 Allocating the transaction price in a contract with multiple performance obligations in which the entity acts as both a principal and an agent

As discussed in the June 2014 TRG meeting, the standard does not illustrate the allocation of the transaction price for a contract with multiple performance obligations in which the entity acts as both a principal and an agent (see Chapter 28 at 3.4 for a discussion of principal versus agent considerations).36 Example 29.26 below illustrates two acceptable ways to perform the allocation for this type of contract that are consistent with the standard’s objective for allocating the transaction price. Entities need to evaluate the facts and circumstances of their contracts to make sure that the allocation involving multiple performance obligations in which an entity acts as both a principal and an agent meets the allocation objectives in IFRS 15.

3.3.1 Application questions on the variable consideration allocation exception

3.4.1 Application questions on the discount allocation exception