How the IASB’s new framework for recognizing revenue affects the accounting for related costs
As we summarized here, the IASB has issued IFRS 15, Revenue from Contracts with Customers, effective for annual reporting periods beginning on or after January 1, 2017 (NB this was subsequently amended to January 1, 2018). In addition to setting out new or more detailed requirements for recognizing and measuring revenue, the standard also addresses the other key aspect of revenue-generating transactions: how to treat costs incurred to fulfil a contract. We’ll briefly review here how the standard addresses that area.
Costs incurred in fulfilling a contract may fall by their nature under the scope of another standard and be accounted for accordingly – for example, as inventory or as property, plant and equipment. Otherwise, the entity recognizes an asset for such costs when they meet all the following criteria:
- (a) the costs relate directly to a contract, or to an anticipated contract that the entity can specifically identify (for example, costs relating to services to be provided under renewal of an existing contract, or of designing an asset to be transferred under a specific contract that hasn’t yet been approved);
- (b) the costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future; and
- (c) the costs are expected to be recovered.
These costs might include direct labour (for example, salaries and wages of employees who provide the promised services directly to the customer); direct materials (for example, supplies used in providing the promised services to a customer); allocations of costs relating directly to the contract or to contract activities (for example, costs of contract management and supervision, insurance and depreciation of tools and equipment used in fulfilling the contract); costs explicitly chargeable to the customer under the contract; and other costs incurred only because an entity entered into the contract (for example, payments to subcontractors). However, they don’t include general and administrative costs (unless those costs are explicitly chargeable to the customer under the contract), or costs of wasted materials, labour or other resources to fulfil the contract that were not reflected in its price. These kinds of costs are recognized as expenses when incurred, along with any costs relating to past performance, or which can’t be reliably allocated between satisfied and unsatisfied performance obligations. An entity is precluded from deferring costs merely to normalize profit margins by allocating revenue and costs evenly over the life of the contract.
An entity also recognizes an asset for the incremental costs of obtaining a contract with a customer, if it expects to recover those costs – for example, for items such as sales commissions or finders’ fees that it wouldn’t have incurred if it hadn’t obtained the contract. It expenses costs that it would have incurred regardless of whether it had obtained the contract, unless again the costs are explicitly chargeable to the customer.
Assets recognized under IFRS 15 are amortized on a systematic basis consistent with the transfer to the customer of the goods or services to which the asset relates (see discussion here). This will usually reflect performance under a specific existing contract; however, in some circumstances, consistent with the first of the criteria set out above, the amortization period might take into account a specifically anticipated future contract. As a practical expedient, IFRS 15 states an entity may recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset it otherwise would have recognized is one year or less.
The entity also assess the carrying amount of the unamortized asset for impairment and recognizes an impairment loss in profit or loss to the extent that its carrying amount exceeds the remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates, less the costs relating directly to providing those goods or services that haven’t yet been recognized as expenses.
Currently, IAS 18 states that “revenue and expenses that relate to the same transaction or other event are recognized simultaneously,” but doesn’t describe in detail how an entity should implement this concept, or how it identifies whether a particular expense relates to a particular item of revenue. IAS 11, in the context of construction contracts, provides more detailed guidance on identifying contract costs and on recognizing those expenses with reference to the stage of completion of the contract activity, consistent with contract revenue. However, the accounting under IFRS 15 for those kinds of costs won’t necessarily be entirely consistent with that under IAS 11 either, for example because IFRS 15 might cause different costs to be recognized as assets, or because it might drive a different amortization period for those assets. For entities where accounting for revenue is inherently intertwined with accounting for related costs, this may be another respect in which IFRS 15 affects current systems and procedures, and a further reason to assess the impact of the standard sooner rather than later.
The opinions expressed are solely those of the author