IFRS 15

Question 1

IFRS 15 Step 1

Answer 1

Identifying the contract with the Customer
- Contract approval and commitment
- Clear and explicit what each party is entitled to in terms of the goods and services that will be exchanged
- Identifiable payment terms
- Commercial substance
- Entity will collect the consideration to which it will be entitled
- Contract can be written, verbal, or implied

Question 2

IFRS 15 Step 2

Answer 2

Identify the Separate Performance Obligation
-Key is distinct goods or services. (E.g. Phone and warranty)
- Distinct if sold separately or could be, with distinct function and profit margin. Considerations:
1. No significant integration service
2. No significant modification
3. Not highly dependent on other promised goods/services.

Question 3

IFRS 15 Step 3

Answer 3

Determine the Transaction Price:
Consideration for transferring goods/services.
- Exclude amounts for third parties (e.g., VAT).
- Variable consideration possible due to discounts, refunds, price concessions, performance bonuses/penalties.

IFRS 15 mandates estimating variable concessions using “expected value” or “most likely amount” methods.

Question 4

Expected Value Method

Answer 4

Multiply possible amounts by probabilities, sum weighted amounts

Question 5

Most Likely Amount

Answer 5

Choose the single most likely amount from the range of possibilities, suitable for scenarios with only two possible amounts (e.g., full bonus or none).

Question 6

A company enters into a contract to construct an asset for a customer. The agreed price is £500,000 and the specified delivery date is 31 December 2019. If the asset is delivered after this date, the company will suffer a late delivery penalty of £20,000 for each week between 31 December 2019 and the actual delivery date
The company expects that the probability of the asset being delivered on time is 80%. But there is a 10% probability that the asset will be delivered one week late and a further 10% probability that the asset will be delivered two weeks late.

Answer 6

Expected value method:

£494,000
[(80% × £500,000) + (10% × £480,000) + (10% × £460,000)

Question 7

A Ltd supplies laptops to larger businesses. On 1 July 2015 A Ltd entered into a contract with T Ltd, under which T Ltd would purchase laptops at £500 per unit.
The contract states that if T Ltd purchases more than 500 laptops in a year, the price per unit is reduced retrospectively to £450 per unit. A Ltd’s year end is 30 June
As at 30 September 2015, T Ltd bought 70 laptops from A Ltd. A Ltd estimates that T Ltd’s purchases will not exceed 500 in the year to 30th of June 2016.
Therefore, T Ltd will receive no discounts on sale price
During the second quarter end, T Ltd went through an expansion and acquired additional 350 laptops from A Ltd.

Answer 7

Most Likely Method
A Ltd recognises revenue of 70 × £500 = £35,000 for the first quarter ended 30 September 2015
T Ltd’s purchasing pattern has changed
It is now highly probable that T Ltd’s total purchases may exceed 500 items and that T Ltd would be eligible to obtain bulk purchase discount.
The key point is that this new purchasing pattern will change revenue application retrospectively for A Ltd, that is the company will recognise:
Revenue of 350 laptops × £450 = £157,500 for the second quarter ended 30 December 2015
Less: Discount of (70 laptops × £50) = £3,500 for the first quarter ended 30 September 2015
= £154,000 in revenues in total from 30 June onwards.

Question 8

IFRS 15 3.1

Answer 8

Existence of a Significant Financing Component
1. Significant Financing Component:
- Occurs when customer payment date is later than goods/services transfer, and time value of money effects are significant.

2. Revenue vs. Finance Income:
   - Adjust if significant financing component exists; treat part of consideration as finance income, not revenue.
3. Exemption for Short-Term Periods:
   - No adjustment needed if the period between transfer and payment is ≤ one year.
4. Objective of Revenue Recognition:
   - Recognize revenue to reflect what customer would have paid in cash at transfer, aligning with fair value and time value of money considerations.

Question 9

IFRS 15 Step 4

Answer 9

Allocate the Transaction Price to Performance Obligation:
1. Principle (For multiple performance obligation):
- Allocate transaction price to performance obligations using stand-alone selling prices.

2. Stand-Alone Selling Price:
   - If not observable, estimate stand-alone prices for goods/services.
3. Considerations in Step 4:
   - Estimate relative stand-alone selling prices.
   - Allocate variable consideration.
   - Allocate discounts.

Question 10

IFRS 15 Step 5

Answer 10

Recognise Revenue when a Performance Obligation is Satisfied:

Recognize revenue when control of a promised good or service is transferred to the customer.

Performance obligation can be satisfied at a point in time or over time.

Criteria for Over Time Recognition:
- Customer simultaneously receives and consumes benefits
- Entity’s performance creates/enhances an asset controlled by the customer
- Entity’s performance does not create an asset with an alternative use, and the entity has enforceable right to payment.

If outcome measurement is unreliable but cost recovery is expected, recognize revenue only to the extent of costs incurred.

Question 11

IFRS 15 Step 5 Overtime can be measured via

Answer 11

Output methods:
Recognise revenue on the basis of the value to the customer of the g&s transferred and includes
* performance completed to date
* results achieved
* milestones reached
* units delivered or produced

Input methods:
Such as labour hours, resources consumed, costs incurred

Question 12

Warranties

Answer 12

The price may be integrated into the total purchase price or specified separately as an optional product.
1 Service type warranties
2 Assurance type warranties

Question 13

Service type warranties

Answer 13

These warranties not only assure that the product is as specified but also provide an ADDITIONAL SERVICE to the customer.

A laptop comes with a service-type warranty that not only guarantees the laptop’s specifications but also includes a hotline for technical support. If the customer encounters issues, they can call for assistance.

Option to buy this warranty separately or if it offers a service beyond fixing defects present at the time of sale, it is considered a distinct service.

Treated as a separate performance obligation

The entity estimates the stand-alone selling price of the warranty and allocates a portion of the total transaction price to the warranty. Recognition occurs as the service is provided.

Question 14

Assurance-type Warranties

Answer 14

These warranties assure the customer that the delivered product conforms to the contract specification but do not include additional g&s.

Treated as WARRANTY OBLIGATIONS. The estimated cost of fulfilling these obligations, such as fixing defects, is accrued as per the requirements in IAS 37.

Question 15

C Ltd manufactures and sells computers that include an assurance-type warranty for the first 90 days.
The company offers an optional “extended coverage” plan under which it will repair or replace any defective part for three years from the expiration of the assurance-type-warranty.
The total transaction price for the sale of the computer alone is £3200
The warranty is priced at £400
The inventory value of a computer is £1440 and C Ltd estimates that it will incur £200 in costs to repair defects that arise within the 90-day coverage period for the assurance-type warranty
Required: Demonstrate how C Ltd will treat and account for the transaction

Answer 15

C Ltd will treat the service-type warranty as a separate obligation given that it can be priced and sold separately.

To record revenue and contract liabilities related to warranties:

Dr Cash/receivables £3600
Dr Warranty Expense £200
CR Accrued Warranty Costs £200
CR Contract Liability £400
CR Revenues £3200

To relieve inventory and recognise COGS:

Dr COGS £1440
Cr Inventories £1440

Question 16

When a performance obligation is satisfied over time, an entity must determine what amounts to include as revenue and costs in each accounting period.
EX: A Ltd started a contract to build a large tower block for a customer. A Ltd estimates that it will take 3 years to complete the project during which period it will have to pay for building materials, wages etc. A Ltd expects to received periodic payments from the customer at various pre-determined stages of the construction.
Suppose that the contract started on 1 January 2015
The final contract price is £1,500,000. In the first year to 31 December 2015:
Costs incurred amounted to £600,000
Half of the work on the contract is completed with a completion certificate for £750,000
It is estimated that further costs to completion of the project will be additional £600,000
Required: Estimate and account for the contract’s profits in 2015

Answer 16

The project will be satisfied over time
A Ltd already has issued enforceable certificates of work completed
IFRS 15 states that the amount of payment that the entity is entitled to corresponds to the amount of performance completed to date, which approximated to the costs incurred in satisfying the performance obligation plus a reasonable profit margin
Given that 50% of the progress is complete:
A Ltd recognises £750,000 as revenue and £600,000 as COGS, leaving a profit of £150,000
The contract asset (Asset not billed yet) will be the costs to date plus profit, that is £750,000. Given that this amount is not billed yet, none of it is receivables yet.

Question 17

Bramble is an information technology (IT) company specialising in bespoke computer systems for small and medium-sized entities. On 1 November 20X6 Bramble agreed contract terms in writing with Nettle to source a new IT system and provide ongoing technical support for the two years following installation. This was subject to satisfactory credit references being obtained.
The contract price was agreed at £1,350,000. Bramble will invoice Nettle following the successful installation of the IT equipment and payment is due 30 days from the invoice. Satisfactory credit references were obtained on 5 November 20X6.
Bramble normally charges £1,350,000 for a similar IT system and £150,000 for a two-year technical support contract if these items were bought separately.
The new system was installed on 1 January 20X7 and Nettle was entitled to access the technical support facility from that date. Bramble invoiced Nettle on the 31 January 20X7 and Nettle paid the balance in full in February 20X7.

Required:
IFRS 15 Revenue from Contracts with Customers sets out a 5-step model for the recognition of revenue earned from customers.
Discuss, with suitable calculations, how Bramble should account for the Nettle contract in the year ended 31 March 20X7 in accordance with the 5-step approach under IFRS 15 Revenue from contracts with customers

Answer 17

Step 1: Identify the contract with the customer.
A written contract exists between Bramble and Nettle.

The contract was approved by both parties in November 20X6. The contract creates enforceable rights and obligations. Bramble is obliged to provide the IT system and technical support and will be entitled to receive payment 30 days from invoice date. Nettle is entitled to receive the equipment and the technical support and to pay for the goods/services provided in accordance with the contract terms.

The payment terms have been agreed. Bramble will invoice in the month of installation and
is entitled to payment within 30 days of invoice.

The contract has as Bramble will earn income and incur costs as a
result of the contract. It is probable that Bramble will collect the agreed consideration from Nettle since the relevant credit checks were completed in November 20X6.

Step 2: Identify the performance obligations.
As the equipment and technical support can be bought separately, two distinct performance obligations exist:
* the provision and installation of the IT system and
* the provision of 24 months of technical support post installation

Step 3: Determine the transaction price
Bramble is entitled to received £1,350,000 from Nettle in full settlement of the performance obligations.

Step 4: Allocate the transaction price to the performance obligations
The transaction price is allocated to the performance obligations in proportion to the stand-alone selling price to each item at the inception of the contract as follows:

Selling price £ % Total price Contract price £
IT system 1,350,000 90% 1,215,000
Technical support 150,000 10% 135,000
1,500,000 100% 1,350,000

Step 5: Recognise revenue when the performance obligation is satisfied
The performance obligation in relation to the IT equipment is satisfied on 1 January 20X7
when the system was installed. Therefore, revenue of £1,215,000 should be recognised on
1 January 20X7.

The performance obligation in relation to the technical support is met over a two-year
period. On the basis that the obligation is satisfied evenly over time, this should be
recognised on a monthly basis. Therefore, revenue of £16,875 (135,000 x 3/24) should be
recognised in the year ended 31 March 20X7.

The remaining 21 months of technical support income received should be treated as deferred income in the statement of financial position at the year-end and recognised in the profit or loss account over the rest of the contract term.

Bramble will recognise total revenue of £1,231,875 in its profit or loss account for the year
ended 31 March 20X7.

Question 18

A company enters into 10,000 contracts with customers, all on the same date. These
contracts have very similar characteristics and therefore (as a practical expedient) the company decides to apply the requirements of IFRS15 to the portfolio of contracts rather than accounting for each contract individually.

Each contract involves the sale of a single product at a price of £30. Customers pay for the product when it is delivered and obtain control of the product on the delivery date.

The terms of the contract entitle customers to return the product within 60 days and
receive a full refund of the purchase price. Based on previous experience, the company estimates that 4% of customers will exercise their right of return.

Required:
Explain how the company should account for these transactions.

Answer 18

This question is the application of guidance in IFRS 15.

When the goods are delivered to the customers, the company should not recognise revenue in relation to the products that are expected to be returned. Assuming that the returned products can be resold by the company and are not impaired in any way, the company should recognise the following items in its financial statements:

(a) revenue of £288,000 (10,000 × £30 × 96%)
(b) a refund liability of £12,000 (10,000 × £30 × 4%)
(c) an asset (inventory) equal to the cost of the products that are expected to be returned.

If the refunds actually paid to customers during the 60-day period are not exactly £12,000, the difference should be accounted for prospectively as a change in an accounting estimate.

Question 19

Midsomer, a public listed company, is in the process of preparing its draft financial statements for the year to 31 March 2022.

On 1 April 2021, Midsomer sold maturing inventory that had a carrying value of £3m (at cost) to Norton, a finance house, for £5m. Its estimated market value at this date was in excess of £5m. The inventory will not be ready for sale until 31 March 2025 and will remain on Midsomer’s premises until this date. The sale contract includes a clause allowing Midsomer to repurchase the inventory at any time up to 31 March 2025 at a price of £5m plus interest at 10% per annum compounded from 1 April 2021.

The inventory will incur storage costs until maturity. The cost of storage for the current year of £300,000 has been included in trade receivables (in the name of Norton). If Midsomer chooses not to repurchase the inventory, Norton will pay the accumulated storage costs on 31 March 2025. The proceeds of the sale have been debited to the bank and the sale has been included in Midsomer’s sales revenue.

Required:

Explain how this item should be treated in Midsomer’s financial statements for the year to 31 March 2022 in accordance with IFRS 15. Your answer should quantify the amounts where possible.

Answer 19

This is a repurchase agreement. Although the legal form of the agreement is that a sale has occurred, the substance of the transaction seems to be a secured loan. It is unlikely that a finance company would wish to buy this inventory and it seems much more likely that the finance company is expecting Midsomer to repurchase the inventory in due course. Logically, Midsomer will do this if the sales value of the inventory at the time of repurchase is greater than £5m plus compound interest at 10% p.a. (from 1 April 2021) plus accumulated storage costs.

The application guidance provided by IFRS15 states that such agreements should be treated as financing arrangements if the repurchase price exceeds the original selling price (as in this case).

The £5m should be removed from sales revenue and recognised as a non-current liability. Also, £3m should be added to closing inventory and removed from cost of sales. A further £300,000 should be added to closing inventory and removed from trade receivables.

Interest of £500,000 should be shown as an expense in the statement of comprehensive income and should be added to the carrying amount of the loan.